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03/01/2009

On the Obama Mortgage Plan-Becker

The housing market is in shambles as home prices continue to fall-so far the average house has fallen over 25 percent in value from its peak. New home construction has virtually stopped. Two causes of the bubble in both housing prices and construction are low interest rates that made durable goods like housing more attractive, and unjustified optimism on the part of both lenders and borrowers that housing prices would continue to rise at a rapid pace. Also of possible importance was the inducements provided banks and other lenders by the Community Reinvestment Act and the 1992 Housing Bill to increase loans to subprime buyers. In 1994 subprime mortgages were under 5 per cent of all mortgages, but by 2006 they were about one-fifth of all mortgages, although the precise roles of this legislation and general optimism about the housing market in the increasing share of subprime mortgages has not been established.
In normal economic times, the housing market would be allowed to continue to work off its excess capital stock through still lower housing prices that increased demand for housing, and minimal levels of new housing construction that reduce the supply of housing. In addition, the government might have retreated from encouraging mortgages to persons with poor credit histories and low earnings. The President's plan is to encourage new housing construction partly by seeking to keep mortgage interest rates low for middle class families taking out new mortgages. To achieve this goal, both the Treasury Department and the Fed will continue to buy mortgage-backed securities from Freddie Mac and Fannie Mae, and Treasury will provide up to $200 billion in capital for this purpose. Likewise, instead of reducing subprime mortgages, the President's plan would stabilize and even increase them by giving lenders financial incentives to reduce interest rates to subprime borrowers, and also by cutting mortgage payments on these loans to no more than 31 percent of borrowers' incomes.
Of course, these are not normal times since we are in the midst of a serious recession that will get worse before it gets better. Does the recession, and the high foreclosure rates on homes, justify these unusual steps that will retard rather than hasten downsizing of the housing market? I do not believe so. Posner shows that the plan has many unattractive features, including that it would be a bureaucratic and administrative nightmare. In addition, it will almost surely cost far more than the $75 billion price tag that the administration attaches to the plan. This magnitude of spending on a complicated housing program seems like a bad idea when so much money is being committed toward other programs to help the economy: about $800 billion in a fiscal stimulus package, and probably much more than that in the Treasury's and the Fed's efforts to help banks become solvent and active in the lending market. I am also worried about increasing Fannie and Freddie's stake in the housing market when their policies have contributed significantly to the excessive sub prime mortgage lending.
In a prior post (see my "On the Obama Stimulus Plan", Jan. 11th, 2008) I expressed my skepticism about how much short term effect on the economy will be produced by the fiscal stimulus package since it mixes long term changes in the economy that will have negligible short term stimulus effects-such as support for alternative energy sources- with helping the economy get out of the recession during the next couple of years. I am more confident that the Fed's policy of lowering interest rates and creating bank reserves through open market operations will succeed in stimulating banks to further increase their lending. I also believe it is necessary to increase the liquidity and capital of some banks, and to close other banks that are no longer viable, although so far the policies to do this advanced by the previous and current Secretaries of Treasury do not seem well thought through.
To return to the housing market, during previous housing busts, banks that were heavily involved in the mortgage market would try to avoid foreclosing on properties during bad times since it was costly for them to take possession of large numbers of houses. They would stretch out mortgage repayments, and even cut the amounts owed in order to help borrowers get through difficult times. That did not prevent sizable increases in foreclosures during highly depressed housing markets, but it did keep the number of foreclosures well below the number of borrowers who experienced difficulty in meeting their payments.
It appears that that the relatively simple decision of lenders to avoid foreclosures is much more difficult when banks and other lenders have sold off the mortgages they originated into mortgage-backed securities that pool mortgages originated by many different lenders. For it is not easy to restructure only the fraction of the mortgages that need restructuring in securities that pool a large number of mortgages. I believe there is a case for making it much easier to restructure mortgages in such securities; indeed, to make this more comparable to the ability to restructure mortgages under the old system when banks held on to the mortgages that they originated.

Maria: It's interesting that you compare Barack to Carter, as Carter too inherited the tough situation that arose after Nixon had to devalue the dollar and take us off the "gold standard". Also, this is something of a serious site so we'd expect you to shore up your "claims" with some sort of supporting data; factual stuff if possible. Perhaps a good start might be that of demonstrating how the Bush admin was "superior??" to that of Carter? Or that of the first 40 days of Obama being "worse" in some way?? than Reagan or HW??? BTW has something caused your caps key to get stuck?

Why in the world would the government want to encourage new home building now? There's a huge glut on the market!

Fannie and Freddie should try first to sort out what mortgages they already hold by type of borrower (e.g. speculators, people who refinanced and used proceeds to splurge, homeowners who bought homes they could not possibly afford if interest rates and terms were normal, and homeowners who were talked into refinancing their homes with payments they didn't understand and couldn't afford). Then they should help the last group and foreclose on the rest.

Fan and Fred should use the money from the government to buy back the CDOs they issued and which the government implicitly guaranteed and do the same thing with the mortgages securing the CDOs.

The last thing the Banks need at the moment is to be holding the Title on property that no one wants and in most cases can't afford. I'm talking about the multi-million dollar McMansions that were built until just recently and the shacks that were pawned off on less than sophisticated borrowers in the Innercity by predatory lenders.

The main solution to the problem is keeping people in their houses and receiving some sort of payment, even if it is a percentage of what the Mortgage should be. At least until the Economy improves. This will require a massive restructering of the Real Estate/Mortgage Industry
and the Bankruptcy Laws in the Country. The current Administration's plan is a step in the right direction. Even if it is fraught with complexities and potential problems.

To a Banker, a couple of bucks in hand is better than holding real estate you can't sell. Even at Foreclosure prices.

David...... fair question, but housing starts have fallen from about 2.5 million to perhaps half a million. "Zero" is not the right number for these reasons:

One, it that the glut is not evenly distributed; in some cities housing is doing fairly well. Keep in mind that the US has something over 100 million homes and the average life is not a century so just replacement alone would indicate more than a million units per year.

Two, is that housing typically leads us out of recessions and there's a reason for that too: Consider, when you contract to have a new home built you may only put a few thousand down, but your action creates immediate employment for the amount of labor to build your home........ plus say a multiplier of 4 times that amount....... some of which likely ends up in the auto biz which has the same effect; wages now and paying it off over time.

BTW........ I suspect there is even another problem: That is that the "move up" market is FAR softer than that of the first time buyer whose choices are staying in a cramped apt with their new family, or buying a modest "starter home". The $8k first time buyer incentive will increase this effect.

Unless the McMansions that are much of the problem fall a lot further than they have, they'll still be out of the first time buyer's league. Further? With unease about energy, many, and especially the FTB are going to be leery driving to deep suburbia if there are other options.

Just because there are 100 million homes does not mean that 1 million are falling apart every year. A high percentage of these homes were built in more recent years. Therefore, most of these homes are not in need of replacement.

Additionally, it is unreasnonable for first time home buyers to expect to purchase the "McMansions" you refer to. I agree that the "move-up" market is extremely soft, but there is still a "starter home" for these first-time buyers to get. The starter homes have fallen much less in value than the McMansions you speak of.

Paul: Agreed that the big homes have fallen more than the "must have" sizes.

I don't know what the replacement rate of homes is, and agree that the base in 1920 was much smaller than in more recent years. My point was more to that of the surplus inventory not suiting the market.

For example I'm in Tulsa just now where, to be sure the market is slower than a few years ago, but today's paper reported a 4% rise in home prices and a 10% rise in the price of the average sale. LOTS of apartments are being built, perhaps too many!! and after a few years or months in apts young marrieds will be out looking at starter homes.

It's a little bit interesting to speculate on what happens to older homes these days. In the Tulsa market a fairly typical 25 year old tract home might have $30k worth of delayed maintenance and perhaps a cracked foundation and after one did that work the home would still be in the $150k range and a bit more would buy a new home built to better design and energy standards.

I'd surmise that w/o one million home starts a year, the US economy will not be well at all. At even a $300k average or $250k median one million starts is a $300 billion industry that gins up demand for appliances, furnishings et all that are still largely Made in America.

I'd say the $8,000 first time buyer credit will deliver a good bang for the buck as stimulus.

Jack, New built to better design and energy standards? Most of the ones I've seen built today are pretty shoddy. Especially the McMansions. As a Contaractor I know told me, it's all about "margins", the central principle of Business. Why should I build quality maderate income housing when I can make greater profit building large houses. As for the old housing stock, its a down and dirty, cheap as possible Re-hab and quick sell-off to the first buyer that comes along. And we all wonder why there are problems in the industry?

As for most homeowners, most can make their mortgage payments, but at the same time, most cannot afford the maintanence and upkeep costs that goes along with home ownership. When I bought my place, I had to replace, the furnace, A/C, the roof, carpeting, windows, wiring (conversion from Aluminum to Copper), plumbing fixture stop valves, and put on a new coat of paint. As for paying for all this, there was a deduct in the purchase price. As for current housing stock? It's falling apart faster than it can be rebuilt. And in most cases, it's cheaper to build new than repair.

Neil: Much agreement: "And in most cases, it's cheaper to build new than repair."

........ Well at least the new is financed at 5% over a long time while major repairs put a real dent in already thin incomes.

......... New homes "shoddy?" Probably not so simple and "whose fault" is even more vague. Consider the structure of today's home is guided by the building codes that have actually been strengthened in recent years. Many are using better insulating tech and putting more insulation in the attics with FAR more Energystar homes being sold than in past years. 13 SEER HVAC is now a government mandate (and a GOOD thing too as builders DO just put what they have to for the most part) up from 7 SEER 15 years ago and 10 SEER recently.

But to be fair, what's going on here is that the public is largely a bunch of giddy children buying as much space and flash, dance, and granite as possible in an "upscale" 'hood such that nothing is left for the correct level of insulation, metal ties in areas of strong winds and hurricanes. Even Low E windows for $50/window is relatively new and has to be sold. This factor is the same for virtually all income levels.

NO improvements are being led by "the market" nor by "competition" or education from the builders or HBA. Used home Realtors? Forget it, most barely know what makes a house stand up!

The builder has the choice of selling into that giddy market or not selling much at all. In short we have just finished building some 20 million "new homes" which are dinosaurs though structurally they'll be there for a LONG time. NOW "the government" (us!) is going to help pay the far higher costs of retrofitting what can be retro'd. Ha! and builders? are true "conservatives" who don't want government mandates but rarely build beyond what is mandated.

Since the discussion has degenerated into "Name calling", better a Marxist-Leninist than a "Neo-Con/Neo-Nazi". Using the "tarbucket" is so much easier and much more fun than having too come to grips with the problems at hand in a rational manner.

Huzzah! NEWT GINGRICH for President! Remember to vote the American National Party ticket in every and all Elections. ;)

Make sure to know the state of your finances before contacting your lender. Determine how much income you're bringing in each month, how much you're paying in bills and where you can cut costs. Just a tip!

The last thing the Banks need at the moment is to be holding the Title on property that no one wants and in most cases can't afford. I'm talking about the multi-million dollar McMansions that were built until just recently and the shacks that were pawned off on less than sophisticated borrowers in the Innercity by predatory lenders.